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Tuesday, 10 December 2013

Bitcoin: Of Shady Drug Websites and Space Travel

What is common to Sir Richard Branson’s Virgin Galactic, The University of Nicosia in Greece, Cheapair.com, Baidu, Reddit and a few hundred more business, or probably a few thousands more? Let me give you a hint, the words ‘Silk Road’ may help ring a few bells.

Yes, it’s about “Bitcoins”. So what is a Bitcoin? For those of you, who are blissfully ignorant about Bitcoins- it’s an online currency; or rather an online decentralised cryptocurrency to be specific. “What does it mean?” you ask. To make sense of all that, we need to start from the basics.

Now what is money or currency? To put it in the barest and crudest possible manner and yet capturing the essentials, I will quote a line from the movie “Margin Call”.

“… money; its made up. Pieces of paper with pictures on it so we don’t have to kill each other just to get something to eat”.

And frankly, that’s all there is to it.

Money or the value system of money works when people ‘believe’ that one particular item/currency, has a value.

Now how do you value a 100 rupee note with the face of Gandhi printed on it? It will mean absolutely nothing, if your neighbour, or the grocer, or the milkman, or flipkart for that matter, doesn’t believe that it has the same value as you do. That is where the trick of adding value comes in.

Earlier, money was backed by gold. i.e. the paper money that people had in their hand meant that the issuing authority i.e. the bank or the government, had a defined amount of gold to back it. So the paper was just a matter of representation of the gold, as lugging gold around to buy things would be uncomfortable, as you can imagine. Now this was sometime back. Then as the economy grew, backing money with gold, or the ‘Gold standard’ as it was called, wasn’t enough anymore. So the countries started creating money which was called ‘Fiat Money’, which depended on the perception of the power of the issuing authority. i.e. if the government of India issued Rupees, it was valued by the perception of the government or the country’s ability, which included the industrial capability of India, the political stability, the amount of rupees in circulation, and a host of other parameters. And that’s why to control it, to give credibility to it, we see Raghuram Rajan making policies, and rules and talking to the press about the rupees etc.

Now, online/virtual currency of which Bitcoin is a part of, has various forms. Of all the online currencies, the most visible to regular people (not necessarily most valued or used), is Facebook credits. FB credits, were bought by real money, and used to buy virtual goods. Thus a micro economy is created. Not just FB credits, the coins that people used to buy surfboards, and characters in Subway Surf, or Temple Run, which you can either collet by playing for a long time, or just paying up real money. They all are forms of virtual currency and they were used to buy virtual things.

Systems like that have been in existence for a while, and it was just a matter of time, when people would start ‘believing’ that they were worth something in real life too. Now this is possible only when businesses that sell real goods also thought that it was worth something (or anything). There are a few examples of that actually happening, one such currency is ‘Q Coins’, the virtual currency of ‘Tencent’, which is a Chinese web company, like Google, which offers games, chat services, etc. And Q coins were bought each for 1 RMB or by spending time on the service. Since it had a wide usage, real world businesses started accepting it. And the virtual currency, which was sometimes earned by just spending time on a web service, started to have value in real life, because people ‘believed’ in it. Something similar happened with another virtual currency, the Linden dollars (L$), (the virtual currency) of the alternate reality service ‘Second life’.

Now the question arises, who backs this kind of “money”, the answer is very simple “no one”, and that begins to pose some real difficult questions. But there is a security that arises from a big possibility that Tencent might not close down, and ‘Q coins’ will have value as a lot of people will use it. And even that, is not the kind of place where Bitcoins come from.

So back to the original question. “What is a Bitcoin”? It is an online ‘Currency’ created by an anonymous person or a group of people who use the pseudonym “Satoshi Nakamoto”. The uniqueness of the system is, it’s not managed by a single entity, like Tencent for Q coins, or Linden Labs for “Linden Dollars” (from ‘Second Life’). It’s not just “Un-backed”; it’s also not consolidated, where it can’t be bought down by closing of a website, like Tencent.

It’s purely an algorithm that creates and maintains bitcoins, which ensures that Bitcoins can’t be duplicated. The creation process is called mining, which means creation of a Bitcoin by assigning it a unique identity, and securing it. It’s created out of processing power, that is to say, by solving hard math problems, and since people are ready to spend real money and buy it because they ‘believe’ it has value, it is increasingly used in transactions worldwide, including among others, Virgin Galactic, by which you can hitch a ride to space.

The value of Bitcoins rose from around $13 in January 2013 to $100 in august to $180 last month to around $950 today. So how did the value of Bitcoins increase by leaps and bounds? To explain that, we need to know about Bitcoin exchanges that run on speculation, almost like a stock market but unlike a stock market, where a company is being evaluated based on its performance, and it’s assets, and policies and plans for it’s future, this just pure speculation.

So what exactly does Bitcoin offer? It offers anonymity, and being decentralised, means that it’s like the torrents that we use, can’t be tracked easily and the money is not from a single common source like a bank, rather it goes from one person’s wallet to another. It offers excellent security, because of the base algorithm, that makes it almost impossible to be abused and that is why it’s called cryptocurrency.

The opponents of Bitcoins argue that these are the kind of needs that a typical money launderer would require. Not to mention people who deal with illegal businesses, like the Silk road website, as well as its customers. And there are speculations that the founder of Bitcoin, Nakamoto was directly involved with ‘Silk road’.

There are people who say this is the future of currencies, and there are others who say this is a real “Bubble”, with practically nothing in it. So will it fizzle out and return to 0, or climb to even greater heights, we will never know. But that didn’t stop it from making a lot of millionaires, who put in around $40 in 2011 or even lesser. And one such person a stewardess, already bought a ticket to space worth $250,000 just like Katy Perry, Russell Brand, Ashton Kutcher, Leonardo DiCaprio among others.

So is it worth it to invest in Bitcoin? To know the answer to that question, just do the Math!